In 2019, the most innovative work involving distributed ledger technology (DLT) – blockchain – will focus on the tokenisation of assets, or the ability to represent digital or physical assets and fiat currencies as tokens that can be sold or traded on a network.

DLT has the ability to take anything, from a piece of artwork to gems and real estate, and represent them as cryptographically hashed assets on a peer-to-peer, open electronic network that has no central authority, such as a bank, governing their trade or sale. Representing digital or physical assets as tokens on a DLT-based network enables participants to reinvent processes and develop new business models – uncharted territory from both a business and technology perspective, according to a new report from Forrester Research. Forrester’s 2019 predictions for CIOs placed blockchain among other emerging technologies, such as artificial intelligence (AI) and augmented reality (AR), that will only be embraced by enterprises if they solve real-world problems.

While best known as the foundational technology behind bitcoin and other cryptocurrencies, blockchain is essentially a database built on a distributed, peer-to-peer topology where data can be stored globally on thousands of servers – and anyone on the network can see everyone else’s entries in real-time. Therefore, it’s virtually impossible for one entity to gain control of or game the network because other users would become immediately aware of the attempt. Despite continued claims to the contrary, DLT hasn’t yet had a revolutionary impact on any industry or process, according to Forrester, which argues the blockchain industry should take a realistic approach to marketing its capabilities and be upfront about the challenges in deploying it.

DIGITISING CARS, REAL ESTATE AND EVEN ARTWORK?

Already gaining momentum are new ownership and service models being created by tokenisation – the digitizing of assets that can be sold or traded on DLT. For example, blockchains that tokenise real estate are fast emerging; they allow traditional investors and consumers to buy shares of a property and receive a return on rents or mortgages. The money paid for the shares allows property owners to make additional investments. Polymath, Securitize and Harbor are among the industry’s leading blockchain networks that enable assets – such as commercial buildings – to be tokenised and turned into tradable securities.

One start-up, Jointer.io is focused exclusively on real estate tokenisation, but unlike other services, it doesn’t offer one property as shares that can be purchased. It offers a number of buildings in an index, and participants can buy tokens from that index. The result is less risk and more profit, according to Jude Regev, founder and CEO of Jointer. The problem with buying shares of a single property, Regev argued, is you have to trust the owner’s word that he or she has the equity they claim. For example, if a building owner owes a mortgage lender 80 per cent of the value of the property, the actual equity an investor owns is far smaller than the total value of the building.

Investors might also not know whether a property has a lien on it or some other financial obligation. “And, how are you going to force an owner to pay a dividend every time they take a distribution for themselves? The [digital token] is not really linked to the bank account collecting the rent,” Regev said. “You need to trust the owner to transfer the money from the bank account into some reserve controlled by smart contracts.” “People scam other people,” he continued. “It’s just a matter of time before somebody is going to scam someone using security tokens. Someone is going to sell a property that doesn’t exist or maybe is vacant…, or sell the same equity in a property twice. At some point, the [Securities and Exchange Commission] will jump in.” So instead of offering a single building, Jointer is creating indices from groups of properties – apartment building collectives or commercial real estate holdings.

Investors can then choose indices based on regions, such as New York or San Francisco or Houston. “The idea is you’re no longer tied to a specific property, so you don’t care if the property is above the market [value] or below it, if the owner is selling all the equity or doesn’t have any equity…. You go by the index of the similar properties,” Regev said. “All the properties – the income strength of them – which is managed by institutional interests, will be moved to a main reserve controlled by smart contracts.”

The shares of those properties – represented by coins – can then be used by participants as securities for attaining loans or simply as a financial asset on which they receive a return. Large investors, for example, get a return on 90 per cent of the asset, with the other 10 per cent going to Jointer, Regev said. Smaller investors receive returns based on smaller portions of the asset. Property owners – the ones placing their real estate equity in the pool – get the service for free. For the public, Jointer offers to lend funds to real estate blockchain projects while the return is based on multi-family building indexes.

TOKENISATION COULD USHER IN NEW OWNERSHIP MODELS

Tokenising assets paves the way for entirely new ownership and service models, but work on those models is nowhere near complete. For example, automobiles could be tracked through blockchains by creating a unique hash tied to the vehicle identification number or VIN. Even parts that make up the vehicle could be linked via QR codes that cannot be replicated and thus, ensure the authenticity of the maker. Cars could also someday be owned by multiple entities, each holding a certain number of tokens representing a portion of the vehicle’s overall worth.

The vehicle would then become a service, to be used when needed but not entirely owned by one person or company. Digital rights could also be linked to blockchains, where a hash representing an object – a painting or precious gem, for instance – could be maintained in the immutable record, ensuring not only authenticity among sellers and buyers, but tracking the provenance of the item.

BIG HURDLES REMAIN

Some things, however, cannot be accomplished purely with DLT and cryptocurrencies. For example, you cannot have a high transactional throughput rate with bitcoin and a resistance to malicious attacks. The creator of the open-source blockchain platform Ethereum has been exploring ways to fix the technology’s innate performance issue – the inability for processing capacity to effectively scale. So far, Ethereum is experimenting with two possible fixes. The first, “sharding,” would require a small percentage of nodes to see and process every transaction, allowing many more transactions to be processed in parallel at the same time. Sharding is also expected to maintain most of the desired decentralization and security properties of blockchain. The second solution involves creating data-link layers or “layer 2” protocols that send most transactions off-chain and only interact with the underlying blockchain in order to enter and exit from the layer-2 system, as well as in the case of attacks. Layer 2 protocols transfer data between nodes within a LAN or an adjacent WAN.

Data sent “off chain” can be stored in conventional SQL, Oracle or other databases. While the industry isn’t expecting major breakthroughs in 2019, the pace of innovation is such that it won’t be the root cause of project failures if the system is properly architected, implemented and run. Agreeing on data definitions, what data to share and with whom, what the process looks like end-to-end, what governance principles apply to the network, will continue to be bigger challenges, Forrester’s report said. Another conundrum facing DLT: data is only as accurate as the person entering it and it’s up to a consensus mechanism – a majority of users – to decide what transaction does and doesn’t get added to the immutable electronic ledger. That boils down to the need for rules.

RUNNING AFOUL OF REGULATORS

Business and regulatory issues also represent stumbling blocks. For example, the EU’s General Data Protection Regulation (GDPR) targets citizens’ personally identifiable information (PII), providing transparency around its use and giving people the right to restrict it or request it be deleted all together. While public blockchains can anonymise participants and even the data entries by representing the information with hash keys, it is possible to infer who a blockchain participant is through metadata. Recent reports have pointed to the ability to glean user location data on Ethereum.

For example, the blockchain search engine Etherscan, which is used to look up, confirm and validate transactions on an Ethereum blockchain, can be used to find links between an a user’s IP address and their Ethereum address. Another way DLT technology can be incompatible with regulations such as GDPR is that you cannot exercise your right to be forgotten on a public blockchain. Blockchain, by nature, is not erasable or changeable; it is write-once, append many technology. While there are efforts to make DLT data unobtainable, through cryptographic erase schemes, they are still controversial.

 

This article was first published in the ANZPJ May 2019 edition. Visit the ANZPJ library to read past publications.